Some thirty researchers took part in CEPR's third international workshop on `North-South Macroeconomic Interactions' at the Korea Development Institute (KDI) in Seoul, South Korea, on 27/28 May, This workshop was held in association with the Brookings Institution, the KDI and the OECD, and it focused on the macroeconomic linkages between the OECD and non-OECD economies, with particular reference to the dynamic Asian economies (DAEs). The workshop was organized by Hans Blommestein (OECD), Sangdal Shim (KDI), Ralph Bryant (Brookings) and David Vines (University of Glasgow), a Research Fellow in CEPR's International Macroeconomics and International Trade programmes. Financial support for this series of workshops is provided to CEPR by the Rockefeller Foundation, and further assistance for this workshop was provided by the OECD and the KDI.

Cross-Border Transmission of Macroeconomic Forces

The first session of the workshop was devoted to theoretical and multi-country perspectives on the cross-border transmission of macroeconomic forces between OECD and non-OECD economies. Ralph Bryant and Warwick McKibbin (Brookings Institution) first presented an overview of the results of the nine teams of global modellers who had performed twelve standardized simulations of the effects of three shocks: permanent monetary and fiscal contractions and a temporary oil price increase. They focused on the effects within the OECD because the modellers' treatments of the non-OECD bloc were too diverse to be standardized. The various modelling groups' simulation results concerning monetary and fiscal shocks were qualitatively similar and broadly consistent with theoretical expectations, but they differed in their magnitudes and their assessments of cross- border effects.

A US monetary contraction produced a temporary fall in domestic output and an equiproportionate appreciation of the dollar, a rise in US interest rates, a fall in US domestic prices and small but ambiguous effects on the current account balance; while the effects of such a contraction on the rest of OECD were relatively small and ambiguous. The outcomes of a monetary contraction throughout the OECD were broadly similar (excepting exchange rate movements). A US fiscal contraction reduced domestic interest rates and prices, and led to a depreciation of the dollar, an improved US current account balance and a temporary fall in output. Such a contraction reduced prices and interest rates elsewhere in the OECD but had ambiguous effects on output. An OECD-wide fiscal contraction reduced output and interest rates world-wide and led to a depreciation of the dollar.

The temporary oil price increase produced stagflation falling output and rising prices in some models, while their predictions of exchange rate effects were dissimilar. Their results displayed a surprising degree of agreement in predicting an increase in interest rates, however, in contrast with the ambiguity expected on account of the differing propensities of oil producers and consumers to save.

In the discussion that followed, Steve Symansky (IMF) noted that the disagreement among the models had narrowed substantially since the first workshop of the series (held in London in December 1989 and reported in issue 30/31 of the Bulletin). He maintained that their non-linearity together with their widely varying net foreign assets and debt stocks may account for the observed differences. Michael Beenstock (Hebrew University, Jerusalem) stressed that because the underlying models were non-linear, an assessment of the divergences among them required an examination of their stochastic simulation results.

Representatives of the individual modelling teams then summarized their findings for the non-OECD blocs. Pete Richardson (OECD) explained that the OECD INTERLINK system did not include fully specified macroeconomic models for the non-OECD blocs and specified their import functions as reaction functions, but he noted that world trade, interest rate and the terms of trade had strong effects on the non-OECD blocs. Steve Symansky reported that using MULTIMOD with a quickly fitted model of the DAEs in which their structures resembled those of the OECD economies indicated that US policies and oil price increases had much larger spillover effects on the DAEs than on the OECD economies. Chris Allen (London Business School) used empirically based macro models of Latin America and the DAEs in the NIESR/LBS Global Econometric Model (GEM) to contrast the effects of a US monetary contraction and an oil price increase on these regions, and he found that Latin America responds to adverse shocks with a greater increase in consumer prices because of its lower aggregate elasticities of demand and supply.

Yasuhiro Asami (Economic Planning Agency, Tokyo) found that the correction of US budget and current account balances had a deflationary impact on Asian economies; and he emphasized the need for policy co-ordination among OECD countries and appropriate policy-making in non-OECD countries. John Helliwell (University of British Columbia) described simulation results using INTERMOD which indicated that a US monetary contraction had little impact on developing countries because of the compensating expansion in the rest of the OECD. The results for an OECD-wide monetary or fiscal contraction indicated a sympathetic output loss in developing countries, however; while an oil price increase had a positive output effect on developing countries because they exported significant quantities of oil. Using the Liverpool model, Patrick Minford (University of Liverpool and CEPR) and Michael Beenstock found in contrast that a US monetary contraction exerted a strong adverse effect on developing country exports, which was even greater in the most recent version of their LDC models. Warwick McKibbin emphasized the need to disaggregate the particular sectors in developing countries that may be critical to understanding the transmission mechanisms from OECD to non-OECD countries. He contrasted the asymmetric responses of Asian NIEs and ASEAN-4 groups of countries to US monetary or fiscal contractions: the former more closely resembled the typical responses of the OECD economies.

The first session closed with a general discussion, in which Peter Pauly (University of Toronto) noted that the LDCs' implausible trade elasticities were essentially statistical artefacts which would disappear with proper modelling of the supply side of their trade. Pete Richardson questioned the observed neutral effect of a US monetary contraction on non-OECD regions: since this could change if the dollar appreciated vis-à-vis non-OECD currencies, the modelling of the non- OECD regions' exchange rates was critical. Warwick McKibbin pointed out that even with fixed exchange rates the implied reserve changes would affect the non-OECD economies. Several participants cited evidence that an OECD fiscal contraction exerts a net positive effect on highly indebted non-OECD countries, since the reduction in their interest payments more than offsets the fall in their export revenues. Patrick Minford argued that the observed insensitivity of results to alternative fiscal closure rules in most of the models may change once monetary closure rules are substituted for the passive monetary policy in the present models.

Single-Country Empirical Models

Hans Blommestein opened the second session, on the macroeconomic transmission mechanisms in empirical models of the individual DAEs' external sectors, with an overview of the results of the models for Hong Kong, Singapore, South Korea, Taiwan and Thailand. These considered the effects of the same three shocks under unchanged policy and with appropriate country-specific policy reactions. The outcomes under unchanged policy largely conformed with theoretical expectations: a US fiscal contraction produced typical Keynesian effects of lower output and prices and an improvement in the current account balance; an OECD-wide monetary contraction generally resulted in lower output and prices and a deterioration of the current account balance; while an oil price increase led to stagflation.

In the first of six presentations by the modellers of individual countries, Yoon-ha Yoo and Sangdal Shim (Korea Development Institute, Seoul) reported that income effects dominated price and interest rate effects in the transmission of external shocks in their Keynesian model of South Korea. GDP exhibited a one-to- one relationship with OECD GDP, because exports had an income elasticity of 3 while exports constituted one-third of GDP; while government expenditure was the principal stabilization policy. Ryosaku Sawa (Bank of Japan) questioned the authors' assumption that the unemployment rate was exogenous, the limited role of the interest rate in the informal sector and their neglect of the demand for money.

Mun-Heng Toh (National University of Singapore) presented the the Singapore model, which also had an underlying Keynesian structure and fairly standard results for US fiscal and OECD-wide monetary contractions. He found that an oil price increase benefited Singapore, however, because it is a major oil refining centre. As in South Korea, the main stabilization policy tool was government expenditure, but for a 5% OECD-wide monetary contraction Singapore had insufficient room for manoeuvre. Jean-Pierre Verbiest (Asian Development Bank) maintained that the neglect of the supply side was a serious limitation in the model's specification and argued that Singapore's economy was far more resilient to US fiscal shocks than Toh's model suggested.

Tzong-Biau Lin (The Chinese University of Hong Kong) described the key features of the Hong Kong model again Keynesian in spirit and noted that the results of the simulations results were in agreement with theoretical expectations. Hans René Timmer (Central Planning Bureau, The Netherlands) expressed surprise that the magnitude of effects on Hong Kong of external shocks were very small and emphasized the need to improve the modelling of the supply side.

Damkirng Sawamiphakdi (Thailand Development Research Institute, Bangkok) then presented the model for Thailand, which notably incorporated supply-side features. He found that a US fiscal contraction and an OECD-wide monetary contraction both led to increased output, an improvement in the current account balance and a rise in prices; while an oil price increase induced a cut in output, an initial rise in prices and a worsening of the current account balance. Peter Warr (Australian National University, Canberra) focused on the oil price shock and expressed surprise that the reduction in aggregate demand caused the prices of non-traded goods to fall under a policy of price control. Many participants were concerned by the results that prices rose as output fell and that inflows of foreign capital increased when interest rates rose abroad.

Presenting the results of the trade-oriented macro model of Taiwan, Joan Lo (The Institute of Economics, Taiwan) noted that a US fiscal contraction reduced output but led to an initial rise in prices, so that Taiwan's trade balance with G7 countries deteriorated; an OECD-wide monetary contraction depressed both output and prices but still affected the trade balance adversely; while an oil price increase led to stagflation and a deterioration of the trade balance. He also considered the effects of a nominal exchange rate appreciation in response to a US fiscal shock and stimulating the economy by lowering the bank discount rate in the other cases.

Manor Jusoh (Institute of Strategic and International Studies, Malaysia) reported briefly on how a short-term macroeconometric model for Malaysia currently under development might be used for simulations.

In the general discussion that followed, many participants remarked on the inadequate modelling of DAEs' supply-side characteristics, particularly for the export sector, and stressed that econometric methods must be modified to achieve coherence with received economic theory. Simulations of the models for domestic policy shocks would also improve understanding of the transmission mechanisms and policy effects.

International Economic Linkages

John Helliwell (University of British Columbia) opened the third session, which addressed a variety of special topics concerning international economic linkages, by presenting his paper on `Convergence and Growth Linkages between North and South'. He modified the conventional Solow growth model by adding a human capital component and scale effects to assess whether countries' growth rates will converge in the very long run. He found evidence to support this hypothesis at the global level. At the regional level, however, African countries' growth rates were weakly convergent, while his model could not adequately explain the growth rates of the Asian economies. Andrew Levin (University of California at San Diego) suggested that the observed convergence may be due to the regression of a stationary series on non-stationary variables.

Steve Symansky (IMF) then presented a paper on `Alternative Closure Rules for Developing Country Regions in Multimod'. He considered closure rules to clear the payments balances of highly indebted developing countries by means of private capital flows under fixed-but-adjustable and flexible exchange rate regimes, import controls or tax changes. His model accounted for debt forgiveness and changes in the price of debt. He found that the choice of closure rule had negligible feedback effects on the US economy but affected the developing countries' own performance dramatically. Charles Soludos (Brookings Institution) questioned Symansky's aggregation of all developing countries other than the DAEs as one group.

Warwick McKibbin (Brookings Institution) gave a paper on `The Implications for the Asia-Pacific Region of Coordination of Macroeconomic Policies in the OECD', in which he found major asymmetries and relative price effects in traded goods sectors between the Asian NIEs and the ASEAN countries. Also, OECD monetary policy coordination in the face of a sustained US fiscal contraction would make developing economies in Asia worse off unless they change their own policies. Michael Beenstock questioned the justification for such an asymmetric approach to the modelling of developing and OECD economies, since McKibbin's model included neither policy reactions, forward-looking behaviour nor wealth effects for developing countries. He also questioned the usefulness of a model that combined calibrated and estimated parameters.

Wookyu Park (Korea Development Institute) presented a paper on `M2 Velocity and Expected Inflation in Korea: Implications for Interest Rate Policy', in which he sought to identify the true determinants of South Korea's long-run M2 money demand for purposes of policy-making once the current liberalization of its financial markets is complete. Park found that the M2 equation could be treated as a velocity equation in which velocity is positively related to the opportunity cost of M2 computed as expected inflation less the interest rate on M2 deposits. He concluded that to stabilize money demand the authorities would have to adjust the interest rate on M2 deposits as expected inflation changed. Sung-Tae Ro (Cheil Economic Research Institute, Korea, Seoul) noted that Korea's recent experience indicates that a stable demand for money can coexist with significant changes in the real economy.

Christian Petersen (The World Bank) gave a paper on `The Structure of a World Bank Global Economic Model', which proposed a PC-based modelling scheme to estimate and link macroeconomic models for 135 individual countries using a new four-commodity trade-linkage system. Dominique van der Mensbrugghe (OECD) pointed out that the proposed macro model specification took no account of essential dualities in developing countries while the proposed linkage system ignored the literature on `new trade theory'. Since co-ordinating the work of modellers at the individual country level would prove impossible in practice, he proposed modelling of developing country regions as an alternative first step.

Arthur Camilleri (Department of the Prime Minister and Cabinet, Australia) presented `A Model of the Korean Economy'. The key innovative feature was the specification of a supply bloc in which potential output was determined, which allowed the export volume elasticity with respect to the scale variable to be restricted to unity. Sangdal Shim (Korea Development Institute) stressed that the high income elasticity of export volumes, reported in his Korean model, was an empirical fact. Other participants argued that supply factors should be included in the export volume equation to capture non-price factors, and incorporating a measure of the DAEs' increased openness in estimated trade volumes to moderate high volume elasticities. Future work on Korea also would have to model domestic interest rates following the liberalization of its financial markets.

Conclusions

The concluding round-table discussion focused on the strength of feedbacks between OECD and non-OECD economies and possible approaches to modelling the latter. There was general agreement that the feedback effects of policies originating in OECD on the non-OECD economies (monetary contraction) and vice versa (structural changes) were significant. Participants differed, however, in their assessments of whether models of developing economies should account for development economics paradigms and forward-looking behaviour; of the appropriate level of disaggregation across countries or sectors; and of the choice of closure rules and policy reactions.

Although there was agreement that the modelling of developing countries' labour markets required special care and should pay attention to the Lewis paradigm, this may require sectoral disaggregation and data which was not readily available. Forward- looking behaviour was thought appropriate even in developing economies with repressed financial sectors, since optimizing behavioural assumptions could be built in conjunction with assumptions about institutional rigidities. The debates over levels of disaggregation and the choices of closure rules and policy reactions were important, but they would remain unresolved until econometric practice improves to embed desirable long-run properties and greater knowledge of the models' properties from computing standard policy multipliers.


CEPR intends to publish a selection of the papers presented at this series of workshops in a forthcoming conference volume.